ON THE HORIZON 2026 | LNG in turbulent times

It has been quite the year since the publication of LNG Offshore Production and Regasification Legal and Commercial Risk Management and a natural moment to pause and reflect on what is going on in the LNG market.  In this article Max Lemanski and Guy Leonard re-visit certain aspects of typical project contracts, which have received increased focus in the light of the current geopolitical climate and recent legal issues we have seen as the SANDS team in both London and Oslo continues to work on multiple LNG related matters, including FRSUs, FSUs and LNG carriers.  

The rise and rise of LNG

Over the last year global demand for LNG has continued to rise as energy demands continue to grow.   We have seen substantial growth in maritime LNG projects, while availability of yard slots remains limited due to the ongoing impact of the recent LNG carrier newbuild drive.  The continuing demand for floating LNG import terminals is not surprising.  FRSUs and FSUs offer relatively cheap and quick energy solutions for governments and other relevant stakeholders looking to rapidly increase their available energy and to bolster their energy security through diversification of supply.   The production of LNG offshore (i.e. FLNG) remains difficult, but the importation of LNG through floating terminals remains relatively straightforward.   A port, or other suitable location, can use an FSRU, i.e. a floating LNG unit including the relevant regasification technology without building any onshore regasification infrastructure, thereby significantly reducing both cost and time to market.  The gas can be transferred straight into the receiving country’s energy infrastructure.    Alternatively, the port may utilise an FSU (i.e. just a floating storage unit), which is then connected to an onshore regasification facility or a separate FSRU.   

As for the ship itself, the work required to convert an existing LNG Carrier into an FSU is relatively simple.  It is a little more complex to add the regasification systems for an FSRU.  But it does not have the complexities involved with, say, the conversion of a tanker into an FPSO or of an LNG carrier into an FLNG.  There is also the added benefit of flexibility.  Both FSRUs and FSUs can (in most cases) also function as LNG carriers (see further below).     

Charterers’ right to use the FSRU/FSU as an LNG Carrier

That flexibility can prove lucrative and can provide welcome opportunity to mitigate risk in uncertain times.   In an offshore or terminal project, Charterers (or Customer) are not always ready to take accept delivery of the vessel into the project within the contemplated timeframes.   This could be due to technical issues (e.g. problems with the receiving terminal or delays in the construction of the jetty or other offshore infrastructure). Other reasons may include delays in permitting, issues with other project stakeholders or tax-related issues. Alternatively, it may just suit the Charterers to delay the project for commercial reasons.

In those circumstances, the parties may agree that Charterers can redeploy the FSRU or FSU as an LNG carrier.  This can raise difficult contractual complexities.  For example, what happens to the project documents (e.g. the bareboat charter and the operations and management agreement) during the relevant LNG carrier charter period.  Typically, they will be suspended until the ship is ready for delivery into the project.  What terms would any such charter be on for the carriage of LNG?   In some cases, detailed agreements are drawn up and appended to the project documents, regulating the switch between contracts, the interface issues and the provisions (e.g., confidentiality, restrictions on liens, liability limits etc,) that apply across the different scopes. In other cases, the project documents may merely allow for any such charter to be on the ShellLNGTime2 form, with logical amendments and a particular daily hire rate.  In such cases, questions may arise as to whether there is sufficient certainty of terms or whether there is simply an agreement to agree.   

Political turmoil – what happens next?

As good a solution as LNG is, it is not a sector without risk for the offshore contractor/vessel owner.  World events have become increasingly unpredictable over the last year.  Offshore contractors/owners may well have concerns about the country risks of a particular project and should look to protect itself as best it can.  What would happen if there was an abrupt change of government?  What would happen if access to a particular port is blockaded?  It is best for the owner to include suitable provision in the project documents including both a suitable requisition clause (i.e. a clause dealing what is to happen if the FSRU/FSU is seized) and a change of law clause.  This latter clause should be as detailed as possible, setting out exactly when the clause will bite (i.e. what is a change in relation to what rules/regulations/rules) and the consequences that flow from that change.

Turbulent times – increased focus on non-operational risk

The geopolitical turbulence of the past year has been felt across the energy (and other) markets. Most recently, the blockade of the Straits of Hormuz has caused supply disruption, price spikes and the broader economic consequences, including resurgence of coal use and shorter working weeks etc., which could merit an article (or five) of their own.  Against this background, we see an increased focus on what can collectively be labelled as ‘non-operational’ or ‘non-performance based’ risks, i.e. risk external to the actual performance of the vessel as an FSRU or FSU.  As well as change in law and requisition (addressed above), these include issues such as force majeure, sabotage and sanctions.  We take a brief look at these below.

In case of local risks, from the owner’s perspective the starting point for FSRU and FSU contracts, as with FPSOs, should be that the local risk sits with the project developer or Charterers and should be clearly allocated accordingly.  This should however be applied in a manner that is consistent with the parties’ respective insurance cover and, specifically, with the mutual ‘knock for knock’ indemnity regime; whereby each party takes responsibility for losses, damage or personal injury to its own property (including in the case of the owner, the vessel) and personnel, and that of its respective group.  

This may create mixed results, with different costs or risks resulting from the same circumstance being allocated differently between the parties.  This is important to regulate carefully. For example, an event of sabotage may be considered force majeure, unless the Charterers have a clear obligation to take measures to protect against such event, and have failed to do so.  In such a scenario, which results in damage to the vessel, the owner will be responsible to cover the costs of the repairs and, if applicable, the time and cost of taking the vessel to a repair yard or dry-dock despite Charterers’ breach.  This follows from the typical knock for knock provisions.  These amounts should be covered by the owner’s insurance. However, Charterers’ underlying breach should protect the Owner from any contractual exposure from the resulting non-performance, or from any costs that are not otherwise covered by owner’s insurance; whether by way of off-hire exposure, exportation and re-importation procedures and duties, towage, or port charges etc.,  

Force majeure is often a controversial topic. In part this is due to differing interpretations as to the protections it should grant.  Traditionally, force majeure (if properly defined) in commercial contracts has operated to excuse non-performance, but without necessarily conferring a right to payment. For FSRU/FSU contracts (as with other offshore contracts involving high value vessels) the picture is different. This is due to other essential elements inherent in such projects.  From the owner’s side, payment of the day rate will be of critical importance, to enable it to service its debt under the vessel financing.  Non-payment represents a significant exposure and the focus will therefore be to ensure that its right to payment is protected as far as possible where services are interrupted by force majeure.  Equally, since the consequence of the non-performance will most often be limited to off-hire (as well as certain costs of fuel etc), losing the entitlement to hire where send-out is interrupted by force majeure would provide limited protection.

For Charterers, depending on the project structure, they may be excused from any liability for failure to deliver gas to the project offtakers, but not receive payment. They will therefore be motivated to limit the obligation to pay as far as possible. Generally, this will come down to an allocation of categories of events where hire is payable and where it is not.  It is essential to ensure these are clearly demarcated to avoid overlap.  These issues are typical in the negotiation of any FSRU / FSU project contracts but seem to garner more attention in more turbulent times, where the risks are seen as more tangible and immediate, than in more tranquil times.      

As a final point, it is worth considering sanctions.  The regulation on these can also create challenges depending on the location of the project and the counterparty.  Different sanctions may apply to different parties and one party (often Charterers) may view the others as unnecessarily restrictive, but generally we see a pragmatic approach taken here. Ultimately the vessel owner will need to comply with those applicable to Charterers and Charterers will need to enable the vessel owner not to breach sanctions applicable to it, whether by law or through its other commitments (e.g. to its lenders).  Questions arise as to whether non-compliance with sanctions should be seen as breach, where the sanctions would not otherwise apply to the non-compliant party.  Also, where there is a risk of sanctions being imposed on temporary or tenuous basis by one of the applicable authorities, there may be a need for creative regulation to enable compliance without forcing a termination of the project.

In conclusion, it really has been quite the year and the specialist SANDS shipping and offshore energy team in both London and Oslo continues to advise LNG clients navigate their way through these turbulent times.